Avoid These Car Financing Mistakes

Americans take on at least 2.3 million auto loans every year worth a dollar volume of $52.8 billion. Car financing allows buyers to spread out their payments for years. It’s an affordable way to get the car of your dreams.

While there are several options available, taking the first one you’re offered isn’t always the right choice. You’ll need to consider the type, rate, and conditions of the loan as well as your own credit and budget.

Read our guide for an overview of several car financing mistakes first-time loan applicants make and how to avoid them. 

Don’t Get the Wrong Type of Loan

There is more than one type of auto loan, and choosing the wrong one has several disadvantages. You could pay more, end up unprotected, or even lose your car if you stop making payments.

The most common types of loans are simple interest, pre-computed, secured, and unsecured. Knowing the differences between them helps you make the right choice.

A simple interest car loan uses your interest and principal to calculate your monthly payment. You’ll pay more in interest than in principal at first but then it will switch. Each month, you’ll need to make both types of payments.

A pre-computed interest loan calculates the total interest for your entire car loan and applies a monthly payment. You’ll pay interest upfront and then payments will apply to the principal. Not all states allow this type of loan.

You can get a secured car loan through a lender or dealership. They’ll take your car as collateral if you stop making payments.

An unsecured loan is an option if you have excellent credit. Your car won’t be used as collateral, but the lender may file for collections or litigation if you miss or stop making payments.

Don’t Forget to Check Your Credit Score

Only 1.2% of Americans have a perfect credit score. 16% have bad credit and 18% have fair credit.

Looking at your credit report is one of the best ways to see what type of auto loan you can afford. It should be one of the first steps you take before applying.

FICO Credit Scores

FICO stands for the Fair Isaac Corporation. It’s a data analytics company that provides credit reports.

Your FICO score matters because 90% of lenders use them to determine whether or not to give you a loan. 

These scores range from:

  • Poor (300-650)
  • Good (670-739)
  • Excellent (740-849)
  • Perfect (850)

Excellent credit isn’t the only way to get a car loan, as there are options for poor or no credit as well. 

FICO Auto Scores

Your FICO auto score assesses your creditworthiness for an auto loan. They range from 250-900, and anything above 700 is a good score.

A FiCO auto score uses information from up to 30 months of past credit behavior.

Factors that affect your FICO auto score include:

  • Past auto loans
  • Increasing or decreasing balances
  • Payment amounts

FICO auto scores are perfect for anyone who’s in debt or has a short credit history but is low risk in all other categories.

What Affects FICO Scores

Several factors determine your FICO score. It’s made up of:

  • 35% payment history
  • 30% current debt
  • 15% length of credit history
  • 10% types of credit used
  • 10% new credit

Payment history refers to whether or not you’ve paid your accounts on time. Any late or missed payments or bankruptcies decrease this segment of your score.

Americans owe $1.36 trillion in auto debt alone. The current debt section of your FICO score looks at everything you owe across all your accounts.

A high amount of debt won’t decrease your score. This segment is based on the amount you owe compared to your available credit and assets.

Length of credit history is determined by how long you’ve held all your accounts.

To improve the “types of credit” segment of your score, use a mix of retail accounts, credit cards, loans, and mortgages.

Keep your new credit segment score high by avoiding the mistake of opening several new accounts one right after the other.

Your credit ratings determine your loan rate and terms and whether your application will be accepted. You should always check them before applying for a loan.

Don’t Forget the Down Payment

down payment is a sum of money you’ll need to give your borrower before they’ll give you a loan. The recommended amount for car loans is 20% of the sticker price.

A large down payment means a smaller car loan. It’s especially useful if you’re a used car buyer with poor credit.

Don’t Choose the Wrong Loan Term

Modern car loan terms range from 24-84 months. A longer term means lower monthly payments but higher interest rates.

To determine your loan term, ask what each monthly payment would be and subtract the car’s cash buying price from that.

A shorter loan term means lower interest rates. A longer term can be a better option if you have poor credit or are on a tight budget.

Don’t Get the Wrong Interest Rate

The rate offered for an auto loan includes two types of payments; interest and principal. Principal refers to the upfront payment of the car, while interest is an additional percentage of this amount that increases over time.

Your interest rate is determined by several factors, including:

  • The Federal Reserve’s benchmark rates
  • Your credit score
  • Length of the car loan
  • The car itself 
  • Pre-approval
  • Co-signers
  • Down payments
  • APR

Improving your credit score will lower your interest rates. Pay all your bills on time and keep your credit utilization ratio, a number used to compare your available and used credit, low.

Used car financing can be more expensive than new car financing. This is because older vehicles aren’t as risky to lenders. 

Add a co-signer with a higher credit score onto your loan. It makes you seem more trustworthy to a lender, which leads to lower interest rates.

Pre-approval gives you more leverage when negotiating your interest rate with a dealership.

Your APR or annual percentage rate is the annual interest rate on your loan, expressed in a percentage. The lower it is, the less you’ll pay for interest.

A larger down payment reduces the size of your loan, and this can reduce your interest rates. It also allows you to make smaller monthly payments.

Don’t Ignore the Terms and Conditions

A car loan is like a contract between you and a lender. It should contain several different types of terms and conditions, including:

  • Loan terms
  • Insurance and maintenance terms
  • Registration and loan payoff requirements
  • Resale, theft, and accident conditions
  • Loan default and repossession terms

Like any legal document, you should read your car loan agreement thoroughly. Be sure you’ve found the best deal and won’t have a nasty surprise down the road.

Don’t Get the Wrong Insurance

Types of insurance you may not want as part of your car financing include liability, credit, and collision insurance.

Buying your own liability insurance saves you money in the long run.

Credit insurance covers loan payments and protects your property if you become injured or sick, lose your job, or die. Individual life and disability policies offer similar protection and are more affordable.

Collision insurance may be required to cover the cost of repairs after accidents when you’re at fault. It keeps lenders from repossessing your vehicle if you don’t make payments. Get your own to save money.

Gap insurance covers the costs if your car gets totaled or stolen.

There are several situations where you might need it. Most of them involve factors that cause your car to lose its value quickly, including:

  • Financing with a low down payment
  • Trading in a car you still owe money on
  • Buying a car with poor resale value
  • Increased mileage
  • Loan terms of 60 months or more

In these situations, gap insurance may be one of the few types that you want to be included as part of your auto loan. It’s an important protective measure that keeps you from needing to pay a large bill.

Don’t Be Afraid to Negotiate

Your interest rate is negotiable. Most dealerships receive a buy rate from the lenders they work with and will charge you more than this suggestion. This gives you room to negotiate it down.

Going to a dealership makes it easier to negotiate because you can speak to an actual human being.

Don’t Avoid the Dealership

There are several options for receiving a car loan, but a dealership is one of the best. They offer competitive rates, allow you to negotiate, and offer incentives like 0% interest rates and cashback.

The best time to visit a dealership is at the end of the summer when new models come out. You can save money by getting deals on older models.

Don’t Forget to Get Pre-Approved

Pre-approval shows that a lender has assessed your financial situation and agrees to lend you a certain amount before you’ve bought a car.

Pre-approval is optional but helpful. It lets you know what you can afford and makes it easier to stick to your budget.

Do Look for Affordable Car Financing

Car financing is a complex process because so many factors affect the rates and conditions of your loan. This includes anything from your credit history to the type of car you purchase and where.

A bit of knowledge about the process can help you get the lowest rates. You should know how much you can afford and how to negotiate for the best loan.

Auto4Less is the best place to trade, buy, or finance your car. Get a car loan from us today.